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Will the Retail Apocalypse Crush Simon Property Group?

Jul 08, 2020 by Matthew DiLallo
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Brick-and-mortar retailers have been under increasing pressure as more consumers shift their shopping online. Many have shuttered locations that aren't generating enough retail sales to turn a profit. Meanwhile, some have closed up shop entirely after declaring bankruptcy.

The shrinking retail footprint is having a significant impact on owners of retail real estate, like real estate investment trusts (REITs). Several might not survive. Because of that, it's a very challenging time for investors in retail REITs.

What is the retail apocalypse?

The retail apocalypse refers to the dramatic reshaping of the retail industry in America. In 2019, retailers closed more than 9,000 stores, a staggering 59% increase from the previous year. The number of retail store closures will likely balloon further in 2020 due to the impacts the COVID-19 outbreak had on the retail sector as many governments forced nonessential retailers to close their doors to slow the spread. Unfortunately, many never reopened as the pandemic caused even more retail store bankruptcies.

While the rise of online shopping often gets the blame for the retail apocalypse, it's not the only factor. Many retailers are struggling under the weight of debt because of a leveraged buyout or aggressive expansion. In addition to that, consumer spending has changed, with younger generations favoring using their disposable income to buy experiences instead of purchasing material goods. Many retailers have been slow to adapt to these changes, causing them to struggle.

How the retail apocalypse is impacting Simon Property Group

Regional malls have been one of the hardest-hit property groups by the retail apocalypse. The subsector was the worst performer among all REITs in 2019, with that underperformance carrying over into 2020 as COVID-19 accelerated the retail apocalypse. The downturn hasn't spared leading mall REIT Simon Property Group (NYSE: SPG), as its stock slumped 11% in 2019 before tumbling another 55% during the first half of 2020.

One factor weighing on Simon Property's stock is the impact store closings have on occupancy levels and rental rates at its malls. For example, occupancy fell from 95.9% at the end of 2018 to 95.1% at the end of 2019. Meanwhile, base minimum rent per square foot barely budged, rising from $54.18 to $54.59, which was less than a 1% increase.

Unfortunately for Simon, market conditions have gone from bad to worse this year as it had to temporarily close its malls to help slow the spread of the COVID-19 outbreak. Because of that, many of its tenants didn't pay their rent.

While Simon has sued some for back payment and is working out deferrals with others, many of its tenants won't survive as they'll likely file for chapter 11 bankruptcy protection. Because of that, Simon recently reduced its dividend and abandoned a deal to buy rival mall owner Taubman Centers (NYSE: TCO).

How Simon Property Group is responding to the retail apocalypse

Simon Property has gone on the offensive to shield its malls from the retail apocalypse's full force. It has invested $8 billion over the past eight years to transform its properties into live, work, play, stay, and shop experiences, adding office space, residential units, and hotels to its shopping malls. It has also redeveloped retail space to serve the needs of experiential tenants like restaurants and entertainment venues and brought in new retail concepts like online retailers.

The company had planned to invest as much as $5 billion in more redevelopment projects over the next five years. While it has deferred many of these projects because of the COVID-19 outbreak, it will likely move forward with most as conditions improve.

Simon has also taken an active role in making sure many of its tenants survive. The company has partnered with fellow mall owner Brookfield Asset Management (NYSE: BAM) to buy Aeropostale and Forever 21 out of bankruptcy to revitalize those brands so that they can continue renting space in their malls. The company has also considered making bids on other bankrupt retailers, including J.C. Penney (OTCMKTS: JCPNQ) and Lucky Brand, seeing a real estate redevelopment opportunity with the former's department stores and a revitalization candidate with the latter.

One reason Simon has been able to go on the offensive during the retail apocalypse is that it has a top-notch balance sheet, including A-rated credit. That gives it the financial flexibility to make investments to reposition its real estate for the future of retail.

Simon Property Group will be a retail apocalypse survivor

There's no doubt that the retail apocalypse is having an impact on Simon Property. However, it won't deliver a crushing blow to the company like it has for other mall REITs. That's because the company has a top-notch balance sheet and a plan to transform its high-quality retail real estate portfolio into popular mixed-used destination properties. While this shift will take time, and the company will likely experience some bumps in the road, Simon Property has the resources and strategy needed to thrive in a post-retail-apocalypse world.

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Matthew DiLallo owns shares of Brookfield Asset Management. The Motley Fool owns shares of and recommends Brookfield Asset Management. The Motley Fool has a disclosure policy.